Balancing the size of your raise with dilution

09/07/2016By Sammy Abdullah, CFA

At BSV, we frequently look to the ratios and statistics of public companies to guide our thinking for startups. The theory is that large cap public companies are clearly successful (after all, they’ve gone public on a real exchange), so startups would do well to emulate them. In this case, we looked at public tech company financials to understand how many years of cash a startup should have when it’s burning cash. The numbers are staggering.

$ in MM's

TTM

TTM

TTM

Years of

Company

Ticker

Revenue

EBITDA

OCF

Cash

Cash

Marketplaces

Zillow

Z

$741

$7

-$54

$420

8 Years

Content Distributors

TrueCar

TRUE

$264

-$34

-$1

$103

115 Years

Netflix

NFLX

$7,620

$314

-$896

$1,830

2 Years

Pandora

P

$1,290

-$159

-$118

$293

2 Years

Median

$1,290

-$34

-$118

$293

2 Years

SaaS

2U

TWOU

$177

-$22

-$4

$188

50 Years

Benefitfocus, Inc.

BNFT

$212

-$36

-$35

$68

2 Years

Box, Inc.

BOX

$327

-$156

-$38

$183

5 Years

Castlight Health, Inc.

CSLT

$82

-$77

-$58

$121

2 Years

Five9, Inc.

FIVN

$145

-$5

-$1

$58

64 Years

Hortonworks, Inc.

HDP

$155

-$219

-$98

$109

1 Years

Jive Software, Inc.

JIVE

$202

-$14

-$10

$108

11 Years

Lifelock

LOCK

$632

$35

-$38

$156

4 Years

Marketo, Inc.

MKTO

$241

-$51

-$4

$100

26 Years

MobileIron, Inc.

MOBL

$158

-$65

-$35

$85

2 Years

Secureworks

SCWX

$362

-$57

-$18

$124

7 Years

Appfolio, Inc.

APPF

$90

-$8

-$2

$22

14 Years

Twilio

TWLO

$219

-$30

-$2

$261

164 Years

Instructure

INST

$92

-$48

-$21

$62

3 Years

Mindbody, Inc

MB

$120

-$24

-$13

$88

7 Years

Xactly

XTLY

$81

-$17

-$7

$46

7 Years

Median

$167

-$33

-$15

$104

7 Years

*OCF defined as Net Income + Depreciation and Amortization, Total + Other Amortization +

Other Non-Cash Items, Total + Change in Working Capital

We follow 80 public tech companies, but for this analysis we only show the 20 that are burning cash. On median, depending on the sector, the data show that a cash burning public company will hold 2 years of cash if it’s in the Content Distribution Space and 8 years of cash if it’s SaaS or a Marketplace. That’s a massive cushion, especially relative to the 12 to 18 months of cash we typically see startups raise each round. So should startups be raising 2 to 8 years of cash each round? Not necessarily.

The reason these public companies hold so much cash on their balance sheets is because that cash was raised at very high valuations so dilution was minimal. However, if you’re a Series A company, your valuation probably falls somewhere between $5mm and $15mm (pre-money), not hundreds of millions or billions like these publics, so raising 2 years of cash if you’re burning 6 figures per month can be painfully dilutive. In this case, emulating public companies isn’t optimal and raising 2 to 8 years of cash is overkill. To better understand the dilution impact, the table below shows how much dilution you would absorb if you raised cash at a certain pre-money valuation. For instance, if you have a pre-money valuation of $10mm and raise $3mm of cash, you’re going to dilute yourself and current investors by 23% (3/(10+3)).

Pre- Money Valuation

$5,000,000

$6,000,000

$7,000,000

$8,000,000

$9,000,000

$10,000,000

$11,000,000

$12,000,000

$13,000,000

$14,000,000

$15,000,000

$500,000

9%

8%

7%

6%

5%

5%

4%

4%

4%

3%

3%

$1,000,000

17%

14%

13%

11%

10%

9%

8%

8%

7%

7%

6%

$1,500,000

23%

20%

18%

16%

14%

13%

12%

11%

10%

10%

9%

$2,000,000

29%

25%

22%

20%

18%

17%

15%

14%

13%

13%

12%

Raise

$2,500,000

33%

29%

26%

24%

22%

20%

19%

17%

16%

15%

14%

$3,000,000

38%

33%

30%

27%

25%

23%

21%

20%

19%

18%

17%

$3,500,000

41%

37%

33%

30%

28%

26%

24%

23%

21%

20%

19%

$4,000,000

44%

40%

36%

33%

31%

29%

27%

25%

24%

22%

21%

$4,500,000

47%

43%

39%

36%

33%

31%

29%

27%

26%

24%

23%

$5,000,000

50%

45%

42%

38%

36%

33%

31%

29%

28%

26%

25%

The table below refines the analysis a bit further, showing you much incremental dilution you absorb if you raise an additional $500k of cash. For instance, if your pre-money is $10mm, every $500k you raise will dilute you by 5%.

Pre- Money Valuation

$5,000,000

$6,000,000

$7,000,000

$8,000,000

$9,000,000

$10,000,000

$11,000,000

$12,000,000

$13,000,000

$14,000,000

$15,000,000

$500,000

---

---

---

---

---

---

---

---

---

---

---

$1,000,000

8%

7%

6%

5%

5%

4%

4%

4%

3%

3%

3%

$1,500,000

6%

6%

5%

5%

4%

4%

4%

3%

3%

3%

3%

$2,000,000

5%

5%

5%

4%

4%

4%

3%

3%

3%

3%

3%

Raise

$2,500,000

5%

4%

4%

4%

4%

3%

3%

3%

3%

3%

3%

$3,000,000

4%

4%

4%

3%

3%

3%

3%

3%

3%

2%

2%

$3,500,000

4%

4%

3%

3%

3%

3%

3%

3%

2%

2%

2%

$4,000,000

3%

3%

3%

3%

3%

3%

3%

2%

2%

2%

2%

$4,500,000

3%

3%

3%

3%

3%

2%

2%

2%

2%

2%

2%

$5,000,000

3%

3%

3%

2%

2%

2%

2%

2%

2%

2%

2%

So how much cash should you raise? At BSV we like seeing a company raise at least 18 months because that gives you 12 months to really grow and then another 6 months to raise the next round if you need it. Additionally, we’re believers in over-raising, especially if you have a high enough valuation: if you’ve valued at a $10mm pre-money and raising $3mm, the safety net of raising an extra $500k (17% more cash) is worth the incremental ~3% dilution. After a successful exit, no entrepreneur ever kicks themselves for raising incremental money, so err on the side of caution and take a little more cash than you need.